Lynn Johannson, Advisor, Sustainability and ESG
January 4th, 2024
Lynn Johannson, President of E2 Management Corporation and Catalyst for THE Collaboration
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AI’s Double-Edged Sword of Retail Investing
Report | Sep 25, 2024
Image: Freepik, AI generated
OSC Research on AI and Retail Investing - Exploring Opportunities, Risks, and Scams
The Ontario Securities Commission (OSC) just dropped two reports about Artificial Intelligence and Retail Investing. The first report explores the 'Use Cases and Experimental Research', and the second report looks at 'Scams and Effective Countermeasures'. Below we share some takeaways of how AI is affecting individual investors on both sides of the equation, good and bad.
AI Use Cases in Retail Investing
While there are many emerging use cases of how AI is being used to enhance the retail investing experience, there are two main areas that people investing in stocks, bonds, ETFs, and other financial instruments without professional management are using new AI tools today.
The first is using AI as a decision support tool. Retail investors are using AI systems to analyze portfolios or the entire market to gain data-driven insights, guidance, and recommendations. Previously, access to this type of intel was either too complex or expensive for ordinary, smaller investors to use on a regular basis. An example of this is via self-directed investment platforms with AI chatbots or financial advisors that can evaluate an investor's objectives and compare them with their stock picks and/or portfolio.
See: A Look Inside 2024 DIY Investing Trends in Canada
The second main use case is trading automation, where retail investors can automate their investing decisions via robo-advisors or AI powered investment funds. This allows individual investors to manage their own portfolios efficiently and without the need for ongoing monitoring. These solutions are popular with ordinary investors because they basically provide low cost, lite touch portfolio management services without large advisory fees.
Select Risks and Challenges
The reports highlights a laundry list of risks for retail investors which is heightened due to the limited financial experience and resources available to them compared to institutional investors. Here are a few challenges to understand and mitigate.
If a retail investor has an investment advisor, they can always ask them a specific question and expect to receive a measured, qualified, and tailored response. This explainability and transparency is different than AI trading systems that often function as 'black boxes' where decision logic is hidden from review. Retail investors who become overly reliant on new AI tools without knowing how they actually work may find themselves in a risky situation. A biases AI model, for example, can lead to bad investing decisions.
See: Generative AI Myths That Founders Should Know
AI systems can have systemic risks like herding behaviour where AI pushes all retail investors to make the same choices because the AI model says so. Retail investors who may lack basic trading knowledge could be disproportionately affected by this, which may increase market volatility, especially during financial crises. Think of how many of us 'follow' google maps down unknown roads yet we can see a steady stream of cars that are also heading down the same unknown road. Did we ever stop and think is this a good decision?
The report highlights a challenge called 'Principal-Agent risk' which describes the danger of an AI tools being used by a larger firm that prioritizes their own profits over the best interests of individual retail investors (unknowingly of course). This could result in a conflict of interest where AI is in fact acting against the best interest of a client.
AI Scams Targeting Retail Investors
With the advancements of generative AI, scammers are creating more convincing phishing ploys, deepfake videos, and even fraudulent investment platforms specifically targeting retail investors. AI is helping fraudsters look more legitimate, making it harder to detect scammers, putting unsuspecting retail investors at risk because they often base their investing decisions from a social media influencer or public endorsement.
See: Can AI Truly Replace Human Financial Advisors?
AI supported Ponzi schemes where scammers advertise fake trading platforms or algorithms driven by AI that provide large profits at low risk. Retail investors are drawn to these schemes to generate quick profits but these platforms are often fraudulent, tricking investors who may never see their funds again.
Protecting Retail Investors
The reports suggests that retail investors can protect themselves from AI powered fraud and manipulation by increasing their financial literacy and knowledge of AI powered scams. According to the findings, prebunking (proactively prevent misinformation) and inoculation strategies can reduce the chance that a retail investor would fall for a specific fraud. that uses artificial intelligence.
Regulation. Measures that require more transparency and disclosures from AI platforms including a clear understanding of how the AI decision logic is being made and ensuring their are accountable for it.
Why This Matters
AI is already changing the retail investing landscape, so the OSC research findings are important especially for retail investors.
See: The AI Revolution in Wealth Management: Top 3 Innovations (and more)
While AI systems are enabling more access at a cheaper cost they also pose new dangers for every day investors. As the sophistication of AI continues to grow, there will be a disproportionate impact for vulernable retail investors.
The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, artificial intelligence, blockchain, cryptocurrency, regtech, and insurtech sectors. Join Canada's Fintech & Funding Community today FREE! Or become a contributing member and get perks. For more information, please visit: www.ncfacanada.org
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